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Renewables in times of economic downturn

As economic activity is sluggish, demand for electricity has fallen by about 15% in Europe, leading to a drop in electricity prices. However, not all producers are equal in the face of this crisis. The legislation offers a comparative advantage to the greenest producers, which have been particularly resilient since the beginning of the year.

Price and volume risk?

Although countrywide city lockdowns have reduced electricity demand by c.10-15%, the impact on sales is less straightforward for renewables producers. First, most of the renewables are protected from price risks thanks to state subsidies, or via private-type contracts ensuring a fixed selling price (PPA).

But, more importantly, the merit order mechanism, which gives priority grid access to technologies with the lowest marginal cost of production, is a competitive advantage for green producers. As electricity cannot be stored (except by pumping up dams), production has to stop at the demand level (pink line), thus most of the fall in demand is to be borne by thermal producers. In this respect, EDF has reduced its nuclear production guidance, from 375-390TWh to c.300TWh.

Illustration of the merit order

Source: AlphaValue

On the other hand, green players face a shortfall due to the fall in the price of carbon on the EU ETS market, because of lower industrial activities. Although the EU can adjust the quantity of certificates to move up prices artificially (via the market stability reserve), we believe that, in the short to medium term, its policy should remain friendly to incumbent power producers, supporting an economic re-launch. The price of carbon is therefore expected to remain low/unfavourable to green power.

Supply-chain disruption?

According to the various sector players, the value chain of renewables has not yet been significantly disrupted by COVID-19 leaving people stuck at home. The delivery of solar panels, which are almost exclusively built in China, are expected to be delayed by no more than weeks. Concerning wind turbines, as production is highly regionalised, the impact is less straightforward. But the communication from the major players in the sector (Orsted for offshore and Enel for onshore, among others) is somewhat reassuring. Not all productions are at a standstill.

On this subject, traditional players are not immune either. The maximum commissioning date for EDF’s Flamanville (France) EPR has been (again) extended, from 2022 to 2024.

A greener tomorrow?

Every effort will be needed to turn a U-shaped recovery into a V-shaped one. Ecological ideals should logically become secondary, abating the pre-COVID ESG urgency.

The last crisis data for OECD countries led to the same conclusion. As gas or lignite turbines were running at full speed to feed the recovery, the carbon intensity of production (grey line) bumped up. But it has not countered the growing weight of renewables in the output mix (pink line). The pace of new installations even accelerated after the crisis.

Renewables energies are safe from crises

Source: Enerdata

Now that renewables are cost-competitive, countries no longer need to hold them by the hand with subsidies, PPAs contracts have become the new standard. We see this independence as a worthy advantage compared to the 2008-09 situation given that the expansive budget policy will be more focused on limiting unemployment rather than greening up the industry.

Moreover, while the firepower of the oil majors seeking to green themselves up was a threat to traditional renewables producers, recent events have considerably reduced their potential for action, leaving the way clear for traditional players.

On a less factual standpoint, one can also believe that the appearance of blue skies and the singing of birds in the usually polluted megalopolis should awaken the environmental consciousness of some and give the Greens clout in the next elections. Good news for the industry.

Valuation-wise

However, this resilience comes at a price. The P/E of alternative producers is on average c.20x and can reach absurd levels (i.e. c.25x for Verbund), which try to justify this because of the growth potential, when, on the other hand, thermal players trade at an average c.10x.

In addition to the volume and price effect, this is explained by the bulk of traditional players’ valuations being based on dividends, whereas 2020 is expected to be a blank year for many.

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Founded in 2007, AlphaValue is the world’s leading provider of Independent European Equity and Credit Research. We provide comprehensive, unconflicted research-only (no execution, no corporate finance) coverage of c. 480 European mid and large cap stocks. We have an average of 46% of negative recommendations at any one time. Learn more at www.alphavalue.com